CLEAN TECHNOLOGY

Growing an American electric car industry, a tale of two companies

The third of a four-part series. Click here for part one and here for part two.

Not long after the auto bailouts, the financial crash and the election of President Obama, General Motors Co. had a choice to make.

It had designed an electric car, the Chevrolet Volt, to prove it could build something besides gas guzzlers. To make this car even close to affordable, it would need a battery unlike any that had been made before.

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Behind President Obama's pledge to "out-innovate" competing nations in clean technology lies two years of effort by the Department of Energy. This series looks at the results in solar power and electric cars.

This battery would have to overcome its own bulk to power the Volt for 40 miles. It would have to repeat this for something like the life of a regular car. It had to be flawlessly safe: One explosion, and the electric car renaissance could be over.

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Somehow, given all these qualities, it had to put the Volt somewhere near the price of a gasoline car today.

To discover that battery, GM had been working with two companies, one Korean and one American. And the time had come to choose.

So it did: In January 2009, GM chose LG Chem, a division of Korea-based LG Corp., to supply cells for the first model of the Volt, launching in late 2010.

The runner-up was A123 Systems Inc. of Watertown, Mass., a racing startup with a world-leading technology and now, a fresh defeat.

The move to get the United States into making cutting-edge batteries to power the electric car isn't over. But the starting gun has fired.

DOE is pursuing a double-edged strategy: striving to help existing U.S. companies stay in business until their costs become competitive, and funding possible game-changing technologies that could establish American leadership in these clean energy sectors.

If GM's Volt takes off, there will be more contracts available to players like A123 and LG Chem. Micky Bly, GM's executive director of electric systems, said it's been developing batteries with A123 and one to two other suppliers.

But to the old hands of the battery industry, the first Volt contract was no surprise. They saw an old theme playing out. In the 1980s, American scientists had devised the lithium-ion battery, the technology that will power today's generation of electric cars. But in the 1990s, Asian firms commercialized them, manufactured them and began exporting them to every corner of the world.

They held the high ground -- on experience, on reputation and in existing factories already moving down the cost curve.

"The money has been spent in China, and the factories are up and running, and they're huge factories, state-of-the-art," said James Akridge, a U.S. battery consultant, when asked whether Asian companies have the edge.

In the late 1990s, Akridge was working for Energizer, developing lithium-ion batteries at a new plant in Gainesville, Fla. Suddenly, world prices dropped, and company leaders realized it was cheaper to buy batteries from Japan than make them in the United States. They sold the plant in 1999.

"When you drop it like we did, lithium-ion, and then others have continued to invest and push forward and develop their infrastructure and raw materials," Akridge said, "and then you say, 'Oh, we'd better get back in the game,' I think your competitive position is weak."

To battle for this ground, experts knew, American firms like A123 would need competitive technology, factories of their own, and time to catch up. It would take hundreds of millions of dollars, whether from the government or investors.

All the while, foreign firms would be homing in on the U.S. market, and doing it on U.S. soil.

That's the picture the Obama administration saw in early 2009, when it had just taken office and the economy lay in ruins. As they designed a stimulus plan to rejuvenate the economy, Obama officials knew they wanted to emphasize manufacturing. Clean energy, including batteries, topped the list.

A lost decade of innovation

Matt Rogers, the energy consultant who became DOE's chief official implementing the American Recovery and Reinvestment Act, believed "the United States' greatest competitive advantage is aligning technological innovation and high technology manufacturing to serve growing domestic and global demand."

"For the last decade, America lost sight of the important linkages along the innovation-manufacturing-deployment chain and lost global leadership in multiple industries as a result," he continued in a 2010 case study for Harvard Business School outlining DOE's approach.

In August 2009, DOE awarded $2.4 billion of stimulus funds to jump-start the U.S. industry. A123 got the second-largest grant, $249 million to build battery plants in Michigan.

In fourth place was Compact Power, a subsidiary of LG Chem, which got $150 million to build a Michigan plant of its own. When this plant is up and running, it will supply the cells for all 60,000 Volts that GM will build, annually, for the car's first edition. (Compact Power has since been absorbed as the North American division of LG Chem.)

This graph shows what the Obama administration would like to see happen with batteries made in the United States as market acceptance and mass production accelerate. Graph courtesy of U.S. Department of Energy.

From a policy point of view, the White House is where it wants to be. Last July, it released a report claiming its grants have begun building a U.S. industry from scratch. Factories in the United States supplied less than 2 percent of the world's advanced vehicle batteries before 2009, the report said, but they are on track to produce 40 percent in 2015.

Along the way, The White House expects battery prices to plunge through sheer manufacturing might and the research and development funded in the stimulus. Take an electric car with 100 miles of range: In 2009, its battery would have cost about $33,000. By 2030, the report said, that same battery will cost just $3,300. That cost cut would translate to smaller batteries like those in the Chevy Volt.

Are these figures realistic? The vagaries of battery chemistry and cost make it difficult to get a straight answer, or to make straight comparisons among the estimates by officials, companies, researchers and policy wonks.

But the ranges provided by most observers, within government and without, overlap in this range: $800 to $1,000 to produce a kilowatt-hour's worth of battery.

The next question -- how quickly this can fall -- is much more controversial. As usual, caveats apply: It depends what specific lithium-ion recipe you're talking about, how many you're making, and when.

One respected estimate, by Boston Consulting Group, says costs will slide to the $250 to $500 per kWh range by 2020. Another estimate last year, by a National Academy of Sciences committee, incensed electric-car supporters by claiming a kilowatt of battery costs between $1,250 and $1,700 today. These high prices, the committee said, would delay the cars' uptake until 2030, even in the most optimistic scenario.

Pushing down the cost curve

According to the Department of Energy's Vehicle Technologies Office, making lithium-ion batteries today at scale -- in batches of several hundred thousand -- costs about $800 per kWh. Patrick Davis, the office's program manager, and Dave Howell, its team lead for hybrid-electric technology, think the batteries can near $300 by 2015.

At first, this would occur at the factory level. With practice, factory managers can optimize the process. And once the plant reaches full bore, certain fixed costs get spread over the whole output, lowering the cost of an individual battery.

Then, Howell and Davis said, the scientists get to work. They'll look for ways to tweak the lithium-ion chemistry to get cheaper, more powerful, more long-lasting. "There is a lot of good things happening in the lab that point to the fact that you can do this," Davis said of the $300 mark. "No one knows where the true bottom of the market is, as far as lithium-ion. But it does get very difficult to reduce cost way beyond $300 per kWh."

Progress could continue beyond that, toward the White House's implied 2030 goal of about $100 per kWh. But after the $300 mark, only new technologies -- developing now at universities and startups -- can take the baton from lithium-ion.

For companies such as A123, the issue isn't whether costs will fall, but whether they'll be the ones to do it. And plenty of investors are hoping they will.

After the GM snub in winter 2009, A123 redoubled its efforts. By August, it had secured the $249 million grant from DOE. This became kindling for its initial public offering in September, which raised $380 million and blasted its stock skyward by 50 percent.

The IPO entered venture-capital lore, a beacon for clean-tech entrepreneurs everywhere. A Reuters columnist called it a "smash-hit."

Fifteen months later, the mood has dulled. As A123 hustles to ready its Michigan factories for production, it has struggled to land a large production contract with a major automaker.

This is the paradox facing American companies. To complete globally, they have to get down the cost curve to where their Asian rivals sit. To get down the cost curve, they need buyers to place large orders of batteries. But no one knows how many buyers will materialize. No one knows if the market will erupt like the iPhone, or wind up a curiosity like the Segway.

A123 has a steep hill to climb

Investors give A123 a longer leash than some public companies, because of the company's technology and reputation, and the knowledge that its promised growth market, electric cars, needs time to develop. But it's a trying exercise. Such companies often, even typically, report negative revenue for years, all the while dispensing cash to build capital assets for the business they don't yet have.

Analysts such as Matthew Crews, a research analyst for Noble Financial who watches A123, aren't demanding steep profits right now. But they do want to see it lining up contracts -- if not with GM, then with any of the major companies planning to roll out electric-drive cars in the next four years.

A123 Systems' battery plant in Livonia, Mich., is the largest one in North America. It is trying to ramp up to full production by the end of 2011. Photo courtesy of A123 Systems Inc.

"We're looking for demand, because obviously all of our financial models are based on demand that doesn't exist today," he said. "So it's based on expectations of the future."

Crews said for A123 to look viable, it needs to hit about $100 million in quarterly revenue in the next few years. In the third quarter of last year, A123 had $26.2 million of revenue. "I think 2012 is a validating year," Crews said, noting that BMW, Mercedes and Ford will have released electric-drive models by then.

Jason Forcier, vice president of A123's Automotive Solutions Group, said it has plenty of contracts -- they just tend to be in other countries right now. A123 is supplying SAIC, China's largest carmaker, with batteries for three different electric-drive cars. In Europe, it's supplying Daimler and BMW with batteries for electric buses and trucks.

"In nearly every case, we're competing against the top 10 battery makers across the globe, which includes the Koreans and the Japanese," he said. "From a cost perspective, there's no freebies out there."

Those are the birds in hand. In the bush, Forcier said, A123 is talking to multiple automakers in China, and in America, it expects to close a large production order with a major car company in 2011.

Theodore O'Neill, an alternative-energy analyst at investment bank Wunderlich Securities, is unconvinced. He said a "giant train wreck" awaits A123 in the next five years.

In 2009, the government was in charge of Chrysler and GM and in a perfect position to push mass production of electric cars. The volume would get American companies' costs down and get them into the game with Asia. "But it's not playing out that way at all," O'Neill said.

China pushes the ball down the field

The Volt will debut in the several thousands; the next year, annual production ramps up to a couple ten thousand. "It's just tiny, tiny numbers that just aren't nearly enough to get A123 or anyone else profitable," he said. "Meanwhile, in China, they're really pushing that ball down the field by aggressively building electric vehicles over there."

What does that mean for the American players? O'Neill said those whose whole business is batteries -- such as A123 and Ener1, which also got a Recovery Act grant for manufacturing -- are most vulnerable to Asian competition. More diversified companies, such as Milwaukee-based Johnson Controls, may survive if the battery business comes up short.

"By the time the [U.S.] market really emerges, the Chinese will have been able to make product that's so much cheaper ... I'm not sure it's going to matter," O'Neill said.

In the fuller version of this "train wreck" scenario, some market observers believe, Asian firms gain a decisive edge. They already have working plants in Asia, so if demand perks up there as expected, they may advance down the cost curve quicker than U.S. companies awaiting U.S. buyers.

At some point, the cost advantage may widen enough that Asian firms can flush American ones out of their U.S. factories. American demand for electric cars may never match all the factories that are rising in the Midwest. In that case, they'll sit unused.

They'd probably continue most of their R&D in Asia, and they'd be able to sell licenses to American companies wanting to use their battery technology. But at least for the Midwestern manufacturing jobs, they'd have to hire Americans.

Can A123 avoid this "train wreck"? One strategy is to join other companies surfing the Chinese wave. Like many foreign battery companies, A123 has a joint venture that gives it access to Chinese factories, and thus the Chinese market. If A123 could combine Chinese earnings with a major car contract in the United States, that would likely satisfy investors in the short term, and A123's domestic factories could stay open.

Gas prices are another variable -- one that affects the U.S. market more than elsewhere. Historically, low gas prices have pushed Americans toward large, fuel-inefficient cars; price spikes tend to suddenly, and temporarily, boost sales of fuel-efficient models.

Bloomberg New Energy Finance, a research firm, has modeled how different gas prices would affect electric cars. Say American gas prices reach about $3.70 a gallon, adjusted for inflation, in 2030; that's the baseline forecast by the Energy Information Administration. In that case, about 1 in 5 new cars would be either a "pure" electric or a plug-in hybrid like the Volt, according to BNEF Senior Transportation Analyst Glen Walker.

Xavier Mosquet, worldwide leader of Boston Consulting Group's auto practice, said for companies that lost the auto manufacturers' first bids, there's another way to stay alive: Have a better technology.

Who will survive the market 'shakeout'?

"The two ways to win in the business will be either to sign the early electric car manufacturers ... or you will have to have a significantly better chemistry or technology that will give you an edge for the next generation of contracts," he said.

Mosquet expects that next generation to start in 2014 or 2015, with contracts getting signed as early as late 2012; he predicts a "shakeout" of companies that have neither large contracts nor new technology.

A123's lithium-ion technology, originally developed at the Massachusetts Institute of Technology, is considered among the best in the business on weight, performance and quality. On a per-kWh basis, it costs more than some other lithium-ion technologies, but A123's Forcier said it performs better than the one in the first-generation Volt -- LG Chem's -- and that it can do more with less space.

A123 is also contributing to two game-changing research projects funded by DOE. These projects last three years; when they wrap up in 2014, A123 may have first access to technologies vastly superior to what's in the market.

But there's no telling how much progress LG Chem, or other battery makers around the world, will also have made by then. And Micky Bly of General Motors made clear that the supplier's nation of origin doesn't matter; only the battery does.

Bly said GM has been fortunate to get loans from Michigan, the United States and Canada. "But having said all of that, we have to run a business, and we have to make sure we have cost-competitive solutions that meet all of our technical requirements."

"We would not want to be limited [in] other countries because our flag's here in the U.S.," he said. "So we kind of think that way of the supply base."

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